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States Should Exempt Business Purchases From The Sales Tax

Several years ago, I had the opportunity to talk to a group of legislators about sales tax policy. I was asked if I had any ideas for reform. I mentioned the common ideas of broadening the base by taxing services and remote sales, and lowering rates. I also said that states should exempt business purchases from the sales tax. One legislator looked at me like I had three heads and asked, “Do you mean letting corporations off the hook for sales taxes?” He asked where the justice was in a system that would make poor working families pay sales tax but let multinational companies go free. I explained that sales taxes should fall on final consumption — they are, after all, consumption taxes. And they should generally never fall on intermediate purchases or business inputs.

By the way, this is not an original idea. Every giant in the sales tax field, from John Due to John Mikesell to Bill Fox, has been saying this for decades. Indeed, virtually every state tax commission that has studied this issue has concluded that business inputs should be exempt from tax. Why? When you tax business purchases, the tax becomes part of the cost of doing business, and companies try very hard to pass those costs on to consumers. Two bad things then happen. First, consumers unwittingly pay the tax in the form of higher prices. It is a hidden tax and a most cynical way of financing government. Second, consumers often pay sales tax on the tax embedded in the retail price of the goods they purchase. So we are actually taxing a tax. This “cascading” amounts to awful tax policy.

Yet, as the Council On State Taxation has found, business entities pay about half the sales tax in the United States. This is one of the clearest cases of needed tax reform. There will be several proposals to eliminate the sales tax on business purchases in the coming legislative sessions. Legislators would be wise to enact them. This is not a left or right issue. Indeed, The Tax Foundation, the Center on Budget and Policy Priorities, and virtually everyone else who has ever studied the matter agrees that taxing business inputs is unwise.

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